- Fed Chairman Ben Bernanke on Wednesday stressed the need to reduce the US deficit.
- A good portion of our debt is held internally by the US government. Standard corporate accounting procedures don't count internal obligations—and neither should the federal government.
- We and other big countries have had more debt than we have now and done just fine thereafter.
- It makes more sense to look at the costs of servicing our debt rather than just the total percentage relative to GDP—and our debt-servicing costs are well within or even below historic norms.
In his testimony to the House Budget Committee on Wednesday, Fed Chairman Ben Bernanke acknowledged the US economy is well into recovery mode, but once again stressed the need to reduce the country's deficit. Forever adding debt at today's pace wouldn't be prudent, but misconceptions abound regarding the consequences of today's debt levels.
For instance, forecasts say gross general US government debt will hit 100% of GDP next year. But $4.5 trillion of that is categorized as "Intragovernmental Holdings"—meaning debt we owe ourselves. For example, the Social Security department is required by law to buy and hold Treasuries. Debt is held by hundreds of US federal government agencies—this is like taking money from your savings account to buy the groceries and leaving a note to yourself to replace it on your next paycheck. It's not debt in the sense you owe someone else—simply internal accounting. Standard corporate accounting procedures don't count internal obligations as debt—so why should the federal government?
Accounted properly, net debt—that held by the public—is about 53% of GDP.* That may still seem high and is indeed elevated relative to history. However, we are well below historic highs. In the 1940s, net debt was well over 100% of GDP and remained there into the next decade. Folks may argue that debt was accrued from fighting a global war. True! But the economy doesn't care what the debt is for, just that it exists. And we have actually been financing two expensive wars this decade that (hopefully) won't go on forever. Either way, those post-World War II historic debt highs didn't lead to ruin in the period following—and shouldn't today either. Folks also forget Great Britain had hugely elevated debt through most of its 19th century world domination. And other developed nations have had debt to GDP levels as high or much higher, and yet fine economic and market growth followed. In other words, folks want to say that our debt is "too high," but we can't find a formulaic level for developed nations where historically, X amount of debt automatically equaled ruin. Because these levels, historically, haven't proven to be problematic.
Rather than worrying about absolute debt levels (those will always sound staggering) and whether the US is fast approaching economic doomsday, a better question might be: Can we afford what we've got now, especially since some appear to think (mistakenly) our debt payments are spiraling out of control? Yes, easily—thanks to low interest rates, net interest payments are currently about 2.2% of GDP. Amazingly, from about 1979 through 2002, we had lower net debt levels—yet net interest payments through the entire period were higher! And we paid nearly double today's levels from about 1984 through 1996. We paid more interest—yet that was during two mega bull markets. So surely, today's debt costs can't be as problematic as people fear.
The truth is, at some point, we'll see political will swing back toward fiscal conservatism. (Not to worry, it'll swing back the other way sooner or later too.) We see that in austerity measures being passed globally. And look for the deficit to play a big part in political rhetoric this summer and fall—though, undoubtedly, politicians will incorrectly focus on scary absolute numbers instead of putting numbers in proper context. We don't have much faith politicians will suddenly become rational, frugal stewards of our tax dollars (though they might ratchet down some spending in the interest of keeping their jobs). Instead, as the economic recovery gains firmer footing, economic growth will naturally result in higher tax receipts, which helps shrink deficits and net debt as a percent of GDP.
* Treasury Direct, Congressional Budget Office, March 2010 release